Earnings season is in full swing and with each new release comes some more data points on both past and future results. On February 12th management at Dr. Pepper Snapple Group, Inc. (DPS) announced 4Q 2013 and full year results. Last week I looked through both The Coca-Cola Company's earnings report as well as Pepsico, Inc. So why not go for the trifecta and get the third major player in the domestic soda market; and tear through Dr. Pepper Snapple Group's report and update their valuation. On Friday, February 21st, Dr. Pepper Snapple Group closed trading at $51.74 giving a forward dividend yield of 3.17%.
Analysts followed by Yahoo!Finance expect Dr. Pepper Snapple to grow earnings 6.90% per year over the next five years and I've assumed they can grow at 5.18% (75% of 6.90%) for the next 3 years and at 4.50% per year thereafter. Running these numbers through a three stage DCF analysis with a 10% discount rate and summing over 30 years yields a fair value price of $59.36. This means the shares are trading at a 12.8% discount to the discounted cash flow analysis.
The Graham Number valuation method was conceived of by Benjamin Graham, the father of value investing, and calculates the maximum price one should pay for a company given the earnings and book value. Dr. Pepper Snapple Group earned $3.05 per share in fiscal year 2013 and ended with a book value per share of $11.50. The Graham Number is calculated to be $28.09, suggesting that it is overvalued by 84.2%.
Average High Dividend Yield:
Dr. Pepper Snapple Group's average high dividend yield for the past 3 years is 3.54% and for the past 5 years is 3.50%. This gives target prices of $46.30 and $46.82, respectively, based on the current annual dividend of $1.64. Dr. Pepper Snapple Group is currently trading at an 11.1% premium to the average of two high dividend yield models.
Average Low P/E Ratio:
Dr. Pepper Snapple Group's average low P/E ratio for the past 3 years is 13.56 and for the past 5 years is 13.11. This corresponds to a price per share of $46.11 and $44.58, respectively, based off the analyst estimate of $3.40 per share for fiscal year 2014. I'll use the average of the two low P/E ratio models, $45.34, in my target entry price calculation. Dr. Pepper Snapple Group is currently trading at 14.1% premium to this price.
Average Low P/S Ratio:
Dr. Pepper Snapple Group's average low P/S ratio for the past 3 years is 1.45 and for the past 5 years is 1.20. This corresponds to a price per share of $42.81 and $35.43, respectively, based off the analyst estimate for revenue growth from FY 2013 to FY 2014. 2014 revenue per share is estimated at $29.45 based off only the analyst estimate for growth of 0.70%. This only accounts for the effect of expected growth and does not account for potential share buybacks reducing the share count. Currently, Dr. Pepper Snapple Group's P/S ratio is 1.70 on a trailing twelve months basis. Once again I'll use the average of the two P/S ratio models, $39.12, in my target entry price calculation. Dr. Pepper Snapple Group is trading at a 32.3% premium to this price.
Gordon Growth Model:
The Gordon Growth Model is a quick way to calculate the fair value of a company using the current dividend, the expected dividend growth rate, and your required rate of return or discount rate. Assuming a constant 6.00% dividend growth rate and a discount rate of 9.00%, the GGM valuation method yields a fair price of $54.67. Dr. Pepper Snapple Group is trading for a 5.4% discount to this price.
Dividend Discount Model:
For the DDM, I assumed that Dr. Pepper Snapple Group will be able to grow dividends for the next 5 years at the lowest of the 1, 3, 4 or 5 year growth rates or 15%. In this case that would be 7.89%. I annualized the $0.15 dividend payment from FY 2009 as $0.60 in the 5 year growth rate calculation. After that I assumed it can continue to raise dividends for 3 years at 80% of 7.89%, or 6.32%, and in perpetuity at 6.00%. The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases. To calculate the value I used a discount rate of 9%. Based on the DDM, Dr. Pepper Snapple Group is worth $48.89, meaning it's overvalued by 5.8%.
Dr. Pepper Snapple Group's trailing P/E is 17.0 and it's forward P/E is 14.3. The PE3 based on the average earnings for the last 3 years is 17.7. I like to see the PE3 be less than 15 which it is currently over. Compared to it's industry peers Dr. Pepper Snapple Group is undervalued against The Coca-Cola Company (KO) 19.3 and PepsiCo Inc. (PEP) 18.1. Comparisons are on a TTM basis. Dr. Pepper Snapple Group is trading at a PEG ratio of 2.21. That is on par with PepsiCo (2.20) but well below The Coca-Cola Company (2.73). None of the companies are trading at a discount based on the PEG ratio where 1 is generally considered fair value.
Dr. Pepper Snapple Group's gross margins for FY 2012 and FY 2013 were both 58.3% and they have averaged a 58.9% gross profit margin over the last 5 years. The net income margin for the same years were 10.5% and 10.4% with a five year average of 10.1%. I typically like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%. Dr. Pepper Snapple Group is hovering just under the 60% level on gross margins and has consistently been above the 10% net income margin level. I feel it's prudent to make a company to company comparison as well, as each industry allows for different margins. Over the TTM, PepsiCo's gross margin was 53% and The Coca-Cola Company's gross margin was 61%. For net income margin, PepsiCo was at 10.2% while Coca-Cola Company was at 18.3%. Dr. Pepper Snapple Group is right in the middle of its two main competitors on gross margins and on par with PepsiCo with respect to net income margin. Both Dr. Pepper Snapple Group and PepsiCo are trailing The Coco-Cola Company significantly on the net income margin.
Since the end of FY 2008 Dr. Pepper Snapple Group has been awesome at buying back shares. From 2008 to the end of 2013, the share count has decreased from 254M to 205M. That's a total of 19.3% of the shares outstanding since the start and is good for an average annual decrease of 4.2%. This is a pretty amazing feat for just about any company and a trend I'd like to see continue. Although as a dividend growth investor, I wouldn't mind seeing the split of total shareholder return skew more towards the dividend. Share buybacks have been about 55% larger than dividend payments over the last 3 fiscal years.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Dr. Pepper Snapple Group is a dividend challenger just announcing its 6th consecutive year of increasing the dividend. The dividend has been increased at a 7.89%, 10.67%, 12.75%, and 22.28% rate over the last 1, 3, 4, and 5 year periods, respectively. Dividend increases are based off fiscal year payouts and don't necessarily correspond to annual payouts. The increases have been quite impressive in the short time it's been increased and the payout ratio has remained relatively flat even after the large increases. The payout ratio based off earnings per share has averaged 44.1% over the last 4 fiscal years with a low of 41.5% and a high of 46.0%. The dividend is currently well covered by earnings per share.
Dr. Pepper Snapple Group's cash flow has been hit or miss since FY 2008. Operating cash flow has increased from $709M in FY 2008 to $866M in FY 2013 with an average annual increase of 4.1%. Capital expenditures have decreased along the way from $304M in FY 2008 to $184M in FY 2013. Free cash flow has increased from $405M in FY 2008 to $682M in FY 2013. That's an average annual increase of 11%. I like to calculate the free cash flow after paying the dividend as well since dividends are fairly sticky once put in place. Starting in FY 2009 the FCFaD has decreased from $548M to $380M. It even went negative in FY 2012, meaning either cash from the company coffers, or debt, had to be used to cover the difference. Dividends are paid from cash so it's important to check the payout ratio based off free cash flow. Over the last 4 years the FCF payout ratio has averaged 52.3%, but it's been a wild ride ranging from 8.5% to 110%, and two years in the mid 40%. I'd like to see a bit more stability going forward in the free cash flow payout ratio. The average FCF payout ratio is much higher than the payout ratio based off earnings.
Return on Equity and Return on Capital Invested:
Dr. Pepper Snapple Group's ROE has averaged a fairly strong 24.1% since FY 2009 while the ROCI has averaged 12.3%. Its ROE and ROCI have very consistent from FY 2009 until FY 2013 with very little variation. This shows that management is able to consistently earn a high return both on shareholder equity and invested capital. While I'd love to see increasing levels of ROE and ROCI, if it can be maintained at current levels then I'd be happy just as well. Long term debt has decreased by almost 29% since FY 2008 which has led to the long-term debt to equity ratio declining from 1.35 to 1.10. I would like to see the trend of long-term debt declining as the debt-to-equity ratio is a bit high for my liking. The long-term debt-to-capitalization ratio hasn't declined at the rate as the debt because the shareholder equity level declined as well. The LT debt-to-cap ratio has improved though from 57.5% in FY 2008 to 52.4% in FY 2013.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth, we'll now look at how Dr. Pepper Snapple Group has done on that front. The revenue growth since the end of FY 2008 has been fairly unappealing at just a 0.99% average annual increase. Net income has increased at a 3.0% annual rate from FY 2009 through FY 2013. I had to exclude FY 2008 from the calculation to the net loss during that year. The net loss is excusable to me since the company was still getting on its own two feet after being spun off. Revenue growth isn't expected to do much over the next two years with forecasts of just 0.70% and 1.80% growth. Owners will be relying on management to reduce costs and improve operational efficiency in order to spur net income growth.
This chart shows the historical high and low prices since 2008 and the forecast based on the low, average, and high P/E ratios and the expected EPS values. I have also included a forecast based off a P/E ratio that is only 75% of the average low P/E ratio. I like to the look to buy at the 75% Low P/E price or lower to provide for a larger margin of safety, although this price doesn't usually come around very often. In the case of Dr. Pepper Snapple Group, the target low P/E is 13.3 and the 0.75 * low P/E is 10.0. This corresponds to an entry price of $49.61 based off the expected earnings for FY 2014 of $3.40, with a 75% target price of $34.01. Currently Dr. Pepper Snapple Group is trading at a $17.73 premium to the 75% low P/E target price and a $2.13 premium to the low P/E price. If you look at the chart you'll notice that the current price line intersects the average forward P/E line towards the end of 2014. That's good news for long-term investors and could mean that shares are currently trading at an average valuation as you're not paying up for much future growth at current prices.
The average of all the valuation models gives a target entry price of $46.01 which means that Dr. Pepper Snapple Group is currently trading at a 12.5% premium to the target entry price. I've also calculated it with the highest and lowest valuation methods thrown out. In this case, the DCF and Graham Number valuations are removed and the new average is $46.92. Dr. Pepper Snapple Group is trading at a 10.3% premium to this price as well.
Assuming that Dr. Pepper Snapple Group can grow their earnings and dividends at the rates that I assumed, you're looking at decent returns over the next 10 years at current prices. In 2023, EPS would be $5.73 and slapping an average P/E of 14.66 gives a price of $83.63. Over the next 10 years you'd also receive $24.66 per share in dividends for a total return of 109.3% which is good for a 7.67% annualized rate if you purchase at the current price. If you purchase at the target entry price of $46.01 the 10 year total return would be 135.36% or an 8.94% annualized return.
According to Yahoo!Finance, the 1 year target estimate is $52.63 suggesting that the share price has about 1.7% upside over the next year. Morningstar's fair value estimate is $46.00 suggesting about 11.1% downside and has it rated as a 3 out of 5 star stock meaning it's trading near the fair value estimate.
Dr. Pepper Snapple Group, Inc. has a great mix of recognizable brand names. Besides the name sake brands of Dr. Pepper and Snapple, Canada Dry, 7UP, A&W, Sunkist, Hawaiian Punch, Mott's and several more under their control. 2013 was a rough year for the beverage makers, especially those that rely heavily on carbonated soft drinks (CSDs). According to Dr. Pepper Snapple Group's 2013 Annual Report, it was able to grow overall U.S. market share of their CSDs by 0.2% despite lower overall volumes in the U.S.
Dr. Pepper Snapple Group was ahead of the game with the rollout of the 10 series lineup. The major brands, Dr. Pepper, 7UP, A&W, Canada Dry, and Sunkist, were reformulated to have just 10 calories per serving. There's been a lot of backlash towards the soda companies for being a contributor to the obesity epidemic, but Dr. Pepper Snapple Group has been able to bring back lapsed consumers that had lowered or stopped altogether their CSD consumption. This is a huge win for Dr. Pepper Snapple Group to be able to bring customers back when more and more consumers are heading away from CSDs.
One product that I hadn't noticed in the stores is the Canada Dry Sparkling Seltzer Waters. I prefer to drink water myself but sometimes it's just a little too blah for my tastes. Hence the reason why I enjoy sodas and teas as well. But the Canada Dry Sparkling Waters seem interesting. Essentially they're a flavored fizzy water, so you get the flavor of something other than water but the carbonation feel of a soda. I'll be giving these a try the next time I go to the store to see if it's something I like.
Dr. Pepper Snapple Group sees its product lineup as part of a healthy lifestyle that's built on balance. Like most things going to one extreme or the other isn't good for you. Along with the 10 series of CSDs, they've teamed up with KaBOOM! as part of their Let's Play initiative to build playgrounds in order to get children more active. In 2014 they will also be expanding their active lifestyle campaign by joining up with Good Sports to provide athletic equipment and apparel to youth across the nation. Running a successful business is as much about your product or service as it is about your public image. Focusing on getting kids active is just one more step towards reducing the obesity problem plaguing our nation's youth and population overall.
Overall I feel that Dr. Pepper Snapple group is a bit overvalued at current levels. Given the slow forecast revenue growth, net income and therefore earnings growth will have to come from better operational efficiency rather than core growth of the company. The dividend history is rather short but management has made total shareholder return through buybacks and dividends fairly prominent in the annual report so I'm inclined to believe that dividend growth will continue along. The price just seems a bit ahead of itself right now and I personally wouldn't be looking to initiate a position until the price was below $49. At that point shares would yield 3.35%.
What do you think about Dr. Pepper Snapple Group, Inc.. as a DG investment? How do you think the long-term dividend growth prospects are?
Additional disclosure: All charts/images are sourced from my personal stock analysis spreadsheet, Morningstar, or Dr. Pepper Snapple Group Inc.'s Investor Relations page. I am not a licensed investment professional and this article is for informational purposes only.